Business losses extension – carry back to earlier years
The Government introduced legislation in the Finance Act 2021 that provides a temporary extension to the loss carry back rules for trading losses of both corporate and unincorporated businesses.
This blog focuses on how the loss carry back rules can be used and the tax implications of doing so, for unincorporated business owners only. If you would like advice from a company perspective, please do not hesitate to contact us.
A business owner or partner can usually offset a trading loss against general income in the same year, the previous year or both years.
Where a trade loss claim cannot be made against other income a claim can be made to offset the loss against capital gains in the same year. Losses can also be carried forward to be offset against future profits. There are also rules for using a loss in the first four years of trade and the final year of trade. This blog focuses on the S64 ITA 2007 relief for offsetting losses against general income in the current and preceding year as set out above, as the extension applies to this relief.
Currently, rules allow a trade loss to be set against general income of the loss-making year and/or the previous year as already stated. There is however a limit on the amount of income tax reliefs, including trade loss relief against general income, that can be used to reduce taxable income. This is the higher of £50,000 or 25% of adjusted total income. There is no change to these rules.
The extension recently introduced means a trade loss incurred in 2020/21 and 2021/22 can be carried back to be offset against trading profits in the preceding three years, rather than the standard one year for a continuing trade. The extension does not apply to offsetting losses against general income but only to income of the same trade. As an example, a sole trader makes a loss in 2020/21, they can carry the loss back to 2017/18, 2018/19 and 2019/20 and offset the loss against the profits of the trade in those years, priority given to the most recent years first.
Losses used against profits of the same trade, and not general income, are uncapped therefore if the loss is offset against profits of the same trade in the current or previous year there is no cap. The extension does however have a cap of £2,000,000 which applies to the first two years of the three year period.
If you have already made a loss relief claim for 2020/21 and offset against general income of the same year, a further claim under the new rules can be made to carry back any unrelieved losses to the preceding three years.
An individual trader’s profits, losses and other income are:
2017 to 2018 — Trade Profit £1,200,000 — Employment Income £50,000
2018 to 2019 — Trade Profit £1,200,000 — Employment Income £50,000
2019 to 2020 — Trade Profit £500,000 — Employment Income £50,000
2020 to 2021 — Trade Loss £3,000,000 — Employment Income £50,000
The trader makes a claim under section 64 of ITA07 to set the 2020 to 2021 loss against general income of both the year of loss (£50,000) and the previous year 2019 to 2020 (£550,000).
The remaining part of the 2020 to 2021 loss, up to a maximum of £2,000,000, is available to carry back to set against trading profits of 2018 to 2019 and 2017 to 2018 (in that order), and the trader makes a claim under the new provision.
Loss set against:
- £50,000 general income of 2020 to 2021
- £550,000 general income of 2019 to 2020
- £1,200,000 trade profit of 2018 to 2019
- £800,000 trade profit of 2017 to 2018 (cap applied)
£400,000 of the loss remains available to be claimed to carry forward and set against trade profits in future years.
Considerations to make
A loss relief claim should not be considered in isolation, it is important to fully understand how a claim can affect other areas of taxation, such as:
Transferable marriage allowance claims
For married couples and civil partners, the loss relief claim may make a difference to any marriage allowance claims that may or may not have been made already.
If a spouse does not use all of their personal allowance in the tax year, they can elect to transfer part of their allowance to their spouse or civil partner, as long as the person receiving the allowance is a basic rate taxpayer. Therefore, a business owner may have not previously qualified for the transfer because their income was in the higher rate tax bracket but with a loss claim made their income may now be in the basic rate tax bracket, and they now qualify for the claim.
Interaction with interest relief for residential lettings
If an individual lets out a residential property, they can only claim basic rate (20%) tax relief for any mortgage or loan interest incurred, even if they are a higher rate taxpayer. Interest relief is only given up to the lower of the mortgage interest amount and the profits of the rental business, with any excess carried forward to future years.
A loss relief claim carried back to an earlier year may affect the loan interest available to use. Although this will unlikely impact a carry back of a trade loss decision, it is important to be aware of, as any loan interest not relieved when the rental business ceases is lost. Therefore, it is a consideration to make if you have high loan interest and the rental business has recently ceased.
Pension savings – higher rate tax relief
Currently, an individual can make pension contributions up to their relevant earnings each year. A loss carry back claim will not impact the total earnings for this purpose however it may affect the income tax relief available. When a personal pension contribution is made, basic rate tax relief of 20% is obtained at source as the Government ‘top up’ the net contribution e.g. You put £8,000 into your pension fund and HMRC will gross this up, your pension fund will receive a gross contribution of £10,000. If you are a basic rate taxpayer, you have received full tax relief at this point however if you are a higher (40%) or additional rate (45%) taxpayer you can claim the additional tax relief.
A loss claim may mean your income has reduced and you are no longer a higher or additional rate taxpayer, any income tax relief previously received may no longer be correct.
Pension savings – annual allowance excess charge
Currently an individual can receive tax relief on pension contributions up to the annual allowance available in the year. The current annual allowance is £40,000 and unused allowances from the previous three years can also be carried forward and used. However, the annual allowance is reduced if an individual is a high earner with adjusted income over £240,000. If your earnings are above the thresholds your annual allowance is tapered by £1 for every £2 of income above the threshold.
If a loss claim is made the income will also be reduced for the purpose of calculating adjusted income for the pension savings annual allowance. Therefore any loss claim made may result in higher allowances being available than previously calculated. There may be some instances where a pension savings tax charge has been calculated and paid, and the pension scheme opted to pay the charge from the scheme rather than the taxpayer paying this personally. If the tax charge is no longer correct this may be a problem for the scheme to correct.
Gift aid donations
UK taxpayers are able to claim basic rate tax relief on charitable donations made which means the Government ‘top up’ the donation to the charity e.g. if £5 is donated and gift aid is claimed, the total amount the charity receives is £6.25. However, this only applies to taxpayers i.e. individuals with a tax liability, and if gift aid relief has been claimed but an individual does not pay any tax, HMRC will recoup the relief and a tax charge for the relief will apply.
A loss claim may result in an individual no longer having a tax liability and therefore the initial gift aid relief will no longer apply. This could be a n issue for individuals who have donated large sums in a tax year.
High income child benefit charge (HICBC)
A HICBC is incurred where a high earner with income above £50,000 receives child benefit, or someone in their household does. A loss claim may reduce income below the threshold and the tax charge may no longer apply.
This can be a complex area, as a claim may result in a different person in the household being the high earner or the time limit for withdrawing an election to not receive child benefit may have already passed.
Student loan repayments
Currently taxpayers within self-assessment who are liable to repay a student loan, the repayment is calculated and added to the income tax liability and payable as if it were tax.
A loss claim will impact the repayments as the income will be reduced.
Capital Gains Tax (CGT) liability
CGT is calculated based on a taxpayers other income in the year and how much of the tax rate bands are available to use. CGT rates are 18%/28% for residential property and 10%/20% for other assets. As an example, you earn £45,000 in the 2020/21 tax year and make a taxable gain on shares after exemptions of £20,000. You will have £5,000 of your basic rate band available and therefore the gain is taxed as follows:
|£5,000 @ 10%||= £500|
|£15,000 @ 20%||= £3,000|
If a loss carry back claim is made the taxable income will be reduced which in turn will affect the CGT rates.
What should I do?
As always, we encourage you to seek professional advice on how the loss carry back extension will affect you, particularly if any of the above points also apply. The above information is intended as a general guide and your own circumstances will need to be reviewed before a decision is made.
If you would like advice on any of the above points, separate to loss claims, we recommend you contact us as the above points are a general overview only.
Please don’t hesitate to contact us at email@example.com.